Oil bears closing of $600 million triple-short fund bet seen adding to tumult

HOUSTON (Reuters) - This week’s roller-coaster ride in the global crude oil market was likely fueled in part by the sudden liquidation of a $600 million leveraged fund bet on falling prices, market sources said on Wednesday.

Unknown investors in the VelocityShares 3x Inverse Crude Oil Exchange Traded Note (ETN) - which offers the ability to make a bearish bet on prices magnified threefold, with gut-churning ups and downs - bailed out early this week after jumping into the fund in January, ETN data show.

Some 1.8 million shares worth more than $602 million were redeemed on Tuesday, the largest outflow from the ETN in the past year, according to data from FactSet Research.

The selloff suggests that at least some big investors are betting that the worst of an 18-month oil market rout is over after U.S. prices fell to $26 a barrel last month for the first time since 2003. Trading activity has also jumped to the highest levels on record.

“Speculators are getting out of the down oil market. People start unwinding these positions because they think they have gotten their juice out of it,” David Nadig, vice president, director of exchange traded funds for FactSet, said.

The DWTI note inversely tracks the S&P GSCI Crude Oil Index ER, which follows movements in the oil market. And because it offers investors three times the exposure, the impact on the underlying futures is magnified - as is the volatility in the ETN, whose price more than doubled in the first three weeks of January before halving again as oil futures rebounded.

The net asset value of the fund - one of a handful of exchange funds that allows investors to trade oil without the complexity of a futures exchange - fell from close to $1 billion to $417 million on Tuesday and to $322 million on Wednesday, according VelocityShares’ website.

As a result, the mass exodus likely forced the ETN’s issuer, Credit Suisse, to quickly buy back short positions as investors redeemed shares.

VelocityShares, a unit of Janus Capital Group, was unable to comment on the trading activity.

To unwind alone may have amounted to upwards of 40,000 futures contracts on Tuesday, according to estimates by analysts.

There is a day’s lag between when redemptions and creations are ordered and when they show up in share figures, according to Nadig, meaning that Tuesday’s flows were ordered on Monday, when oil reversed a three-day rally to close $2 a barrel lower.

On Wednesday, oil prices surged more than 8 percent to $32.28 a barrel, despite a seemingly bearish report from the U.S. Energy Information Administration showing nationwide crude inventories rose by 7.8 million barrels last week.

Volume in the March West Texas Intermediate futures contract surged on Wednesday to more than 777,000 lots traded, its second highest volume on record, according to data via ThomsonReuters’ Eikon. DWTI volume was also unusually heavy on Wednesday, with more than 1.9 million shares traded.

To be sure, redemptions in the short ETN were not the only driver of higher crude prices. A falling dollar and renewed hopes for a meeting among non-OPEC and OPEC members to curtail global production also bolstered futures values. [O/R]

It is unclear who may have been behind the ETN position, but they ended up on an extraordinarily wild ride. The investment appears to have been made in January, based on asset data showing the note rarely held more than $200 million last year.

Its price peaked at more than $484 on Jan. 20, when oil traded at a low of $26.55 a barrel, but then fell to as low as $225 last week. It surged to $335 on Tuesday before dropping 25 percent on Wednesday. It is still up 24.5 percent for the year.

Reporting by Liz Hampton; Editing by Leslie Adler

Top 4 Inverse Oil ETFs to Short Oil in 2018

We have selected four exchange-traded funds (ETFs) that concentrate on shorting oil stocks. The funds were selected based on assets under management (AUM) as of February 3, 2018. You would use these investments when you think the price of oil will drop. Note that none of the ETFs short actual oil stocks – instead, they seek performance that is the inverse of an index.

Some of these ETFs are leveraged, meaning they may use derivatives, futures contracts or other advanced investment vehicles to achieve their goals. Whenever you see "2X," "Ultra Short," "3X" or "Double" in the fund's name, it is a leveraged fund. Because these funds try to beat an index by two times or more, they can lose twice or three times the amount of money as well. (See also: New Leveraged Oil ETFs Coming Soon.)

Oil prices are currently hovering at around $65 per barrel, as agreements spearheaded by the Organization of Petroleum Exporting Countries (OPEC) to limit oil production have succeeded only marginally in increasing the price of oil. The U.S. Energy Information Administration (EIA) predicts crude prices will average around $60 per barrel this year. No commodity price rises in a straight line. Investors who anticipate short-term drops in the price of oil can use inverse oil ETFs to take advantage of the drops. That makes these ETFs short-term plays in the current oil environment. (See also: The Risks of Investing in Inverse ETFs.)

Some investors use inverse oil ETFs to cover losses they incur in their long oil positions during downtrends. Others abandon long positions during down periods and short an oil index to increase profitability from oil investments. Here is how the top five inverse oil ETFs break down.

1. ProShares UltraPro 3x Short Crude Oil ETF (OILD)

Launched in March 2017, this new ETF is designed to deliver three times the inverse return of the Bloomberg WTI Crude Oil Subindex. Although the stated goal is to return -300% of the index's performance, investors should not expect to achieve this result for longer than one day. Like other inverse funds, the effects of contango and compounding daily returns mean that holding OILD beyond one trading session can generate returns that differ significantly from the results of the index. (For more, see: Leveraged Oil ETFs Come Again.)

2. ProShares UltraShort Bloomberg Crude Oil (SCO)

The Bloomberg WTI Crude Oil Subindex also provides the benchmark for this ETF, but SCO has a goal of achieving the inverse of the index by 200%. This indicates that SCO is also leveraged and carries high risk due to its aggressive methods. Note that the target index tracks oil futures prices.

Average Volume: 1,546,414

Net Assets: $225.86 million

2018 YTD Return: -15.27%

Expense Ratio (net): 1.03%

3. DB Crude Oil Double Short ETN (DTO)

The focus of DTO is light sweet crude oil. The fund's money managers utilize the Deutsche Bank Liquid Commodity index - Optimum Yield Oil Excess Return. This is a short play for investors who want to anticipate crude oil prices as directly as possible. However, since the fund is leveraged, it may hold investments that are aggressive and carry higher risk. (See also: SCO vs. DTO: Comparing Short Oil ETFs.)

Average Volume: 5,738

Net Assets: $28.99 million

2018 YTD Return: -13.25%

Expense Ratio (net): 0.75%

4. United States Short Oil Fund (DNO)

DNO focuses on West Texas Intermediate (WTI) light crude oil. However, it may also engage in futures contracts that involve additional types of crude, as well as diesel, heating oil, gasoline and natural gas. This fund's benchmark is futures contracts that trade on the New York Mercantile Exchange and deal with WTI light crude.

Average Volume: 7,556

Net Assets: $11.31 million

2018 YTD Return: -7.94%

Expense Ratio (net): 0.75%

Anyone shorting oil with the ETFs on this list must watch oil prices diligently and be prepared to act quickly to get out of a short ETF if the price movement of oil is up. Furthermore, it is important to research and monitor each ETF, as they have different investment styles and track different indexes. (See also: The Long and Short of Trading Oil ETFs.)

Investing in oil ETFs can be a complex endeavor. For most investors, even large traders, taking delivery of oil and storing it is simply impractical or impossible to do. Thus, oil ETFs have become a popular instrument with which to access the oil market. In today's market, investors can find ETFs that track the daily price of oil and that aim to mitigate the effects of contango and backwardation, as well as ETFs exposed to companies in the oil sector.

This channel is designed to help you understand oil ETFs, how they are built, how they behave, their objectives, their risks and their rewards.

With 38 ETFs traded in the U.S. markets, Oil ETFs gather total assets under management of $9.40B. The average expense ratio is 0.88%. Oil ETFs can be found in the following asset classes:

The largest Oil ETF is the SPDR S&P Oil & Gas Exploration & Production ETF XOP with $2.25B in assets. In the last trailing year, the best performing Oil ETF was the WTIU at 87.51%. The most-recent ETF launched in the Oil space was the AxelaTrader 3x Inverse Brent Crude Oil ETN DBRT in 09/14/17.